Valuing Energy Efficiency

These are hard times for those trying to design, much less implement, energy efficiency programs. New energy building codes and equipment standards have shrunk the technical potential for conservation. Markets for program staples such as compact fluorescent lamps and low-cost weatherization are being saturated, paradoxically, by the accomplishments of ratepayer-funded programs, especially in states that have been in the vanguard of energy efficiency – a peril of success.

Meanwhile, avoided energy costs, the benchmark for valuation of energy efficiency, are declining. Blame that largely on unforeseen natural gas prices – as low as $2 per million Btu – caused by a drop in aggregate demand, along with recent discoveries of conventional natural gas reserves and new extraction techniques that have opened vast supplies of unconventional gas. This lowered benchmark has raised the cost-effectiveness threshold for energy efficiency measures, causing many marginal measures to fail economic tests, thus lowering the overall economic potential of energy efficiency.

These twin forces (transforming markets and low avoided costs) leave program administrators hamstrung to meet their saving targets. That likely will undermine energy efficiency portfolio standards in many jurisdictions. As a result, a new debate has been touched off about reforming – or replacing – the total resource cost (TRC) test, the main standard for economic valuation of ratepayer-funded energy efficiency in most jurisdictions.

These events haven’t displaced the basic questions governing energy efficiency policy and program design: how much efficiency is technically feasible, how much is economical and what roles the consumers and the utility should play in achieving it.

The supply of energy efficiency (its potential) is largely a technical question. It’s determined by physical factors such as features of energy-efficient technologies, saturation of fuels and end-uses, and prevailing energy codes and standards. (Behavioral factors that affect how consumers decide to invest in efficiency are complex, so the question of market potential hasn’t yet been settled.)

From an economic perspective, energy efficiency policy decisions are fundamentally about the level of ratepayer funds that should be invested in energy efficiency – in other words, what a “negawatt” is worth. This is generally decided systematically through a formal integrated resource planning (IRP) process or through mandated energy efficiency resource standards (EERS). 1 In either case, the question is a matter of perspective: what the relevant benefits and costs are, and what discount rate will best align the stream of future benefits with current expenditures.

These questions have been the subject of a three-decades-long debate among energy policy analysts, who have landed in two camps. In one are those who argue that the criteria that regulators use to determine cost effectiveness tend to overvalue energy efficiency and lead to over-investing. In the other are those who believe the decision rules lead to undervaluation and sub-optimal investment levels.

At the center of this debate is the question of what yardstick to use to value a unit of saved energy. Should regulators

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